Question

​Hassle-Free Web is bidding to provide web hosting services for Hotel Lisbon. Hotel Lisbon pays its current provider $10,100

per year for hosting its web​ page, handling​ transactions, etc.​ Hassle-Free figures that it will need to purchase equipment worth $14,900 up front and then spend $1,900

per year on​ monitoring, updates, and bandwidth to provide the service for 33 years. If​ Hassle-Free's cost of capital is 9.6%​, can it bid less than $10,100 per year to provide the service and still increase its value by doing​ so?

​Hassle-Free can bid as low as ________​(Round to the nearest​ dollar.)

Answer 1

PV of Annuity = P*[1-{(1+i)^-n}]/i

Where, P = Annuity = 1900, i = Interest Rate = 0.096, n = Number of Periods = 33

PV = 1900*[1-{(1+0.096)^-33}]/0.096 = 1900*0.951443/0.096 = $18830.64

Therefore, PV of Total Cost to Hassle Free = PV as above+Upfront Payment = 18830.64+14900 = $33730.64

PV of Annuity = P*[1-{(1+i)^-n}]/i

Where, PV = 33730.64, i = Interest Rate = 0.096, n = Number of Periods = 33

Therefore,

33730.64 = P*[1-{(1+0.096)^-33}]/0.096

33730.64 = P*0.951443/0.096

Therefore, Annuity = P = 33730.64*0.096/0.951443 = $3403.4

Above Amount is the Price they need to charge every year for 33 years to Break Even.

Therefore, they can bid as Low as $3404 and still can add value.